Regulators vs Wilful Defaulters!

RBI governor Raghuram Rajan termed them as ‘freeloaders’ and one estimate has pegged their impact on the banking system at over 84,000 crore rupees. Over the last one year, wilful defaulters have come in the line of fire of both the rbi and the courts- remember the Vijay Mallya and United Bank battle? And now, market regulator SEBI has joined the fray too by proposing restricted capital market access for wilful defaulters. Payaswini Upadhyay reports on what’s in store for freeloaders!

The who, what, how of wilful defaulting is governed by the RBI. It prescribes action against those defaulters tagged as wilful defaulters by banks. The tag of wilful defaulter shuts the access to bank finance. But the door is wide open on capital market finance. So SEBI has now proposed to shut it.

In a discussion paper, SEBI has suggested that a wilful defaulter company and its promoter/director should not be allowed to make a public issue of equities or non-convertible redeemable preference shares. The market regulator has also suggested that existing listed companies, their promoters, group companies and directors tagged as Wilful defaulters should also not be allowed to take control over other listed entity. It has however suggested that the route of rights issue and private placement to QIBs be kept open.

Kalpataru Tripathy Partner- Amarchand Mangaldas“In recommendation 4, they may please clarify that any form of a preferential allotment – why only limit it to preferential allotment to a QIB- I mean preferential allotment to the promoter itself should also be allowed. And I believe that is the intention; SEBI doesn’t want to restrict that. You have said preferential allotment to a Qualified Institutional Buyer- the question may arise does that QIB have access to public funds? So the question of directly or indirectly may need to be addressed if we want to make it very strict.”

Fereshte SethnaPartner, Dutt Menon Dunmorrsett “To my mind, what we need to see if that the wilful defaulter system comes into play by all of the lenders to act simultaneously rather than putting such processes to make them act independently. And obviously with a specific timeline, which if not met, would have adverse consequences for the lenders themselves because the reality is that lenders- when they do not act in a manner for their stake so to speak- are to my mind guilty of dereliction of duty which needs to be dealt with by the regulations.”

Ashwin RamanathanPartner, AZB“In effect they are going to rely on the determination made by a bank which is not a SEBI regulated entity and thereafter prescribe consequences; some might say penal consequences. That said, I think the inherent ability of borrowers, promoters, directors to challenge the wilful defaulter tag continues to be available. The challenge will not be through the SAT or SEBI system but will be through the court system as we saw in the case of Kingfisher few months ago.”

That happened when in September last year, United Bank declared Vijay Mallya and 3 other directors of Kingfisher Airlines as wilful defaulters. But the Calcutta High Court came to Mallya’s rescue when it told UBI that the empowered committee deciding on the wilful defaulter status should have 3 members instead of 4 as per the RBI guidelines. Soon after, RBI’s Master Circular on Wilful Defaulters faced some dilution in the Gujarat HC. The court held that that the directors who are not involved in the day to day functioning of a company cannot be tagged as wilful defaulters and consequently, not restricted to avail of bank capital for new ventures.

Taking a cue from judicial outcomes, the RBI has now revised its Master Circular to include a more robust process for determination of wilful defaulters and a stringent threshold to prove liability of non-whole time directors.

Ashwin RamanathanPartner, AZB“Earlier there was just one committee- now there is a review by another, more powerful committee within the bank. There are terms like show cause notices, opportunity to the promoter to be personally heard. To me, the key is that banks make sure that their internal systems are clear, systematic and absolutely in line with what the provisions are- similar in some sense what we saw in the case of SARFAESI. Right after SARFAESI was promulgated, a slew of cases were thrown out based on the fact that certain technical requirements laid down under the Act were not followed. I don't think that many cases get thrown out now because banks have learnt their lesson. I think a similar approach will be required by banks in the case of wilful defaulters as well.”

Fereshte SethnaPartner, Dutt Menon Dunmorrsett“Firstly, I don’t see any realistic timelines within which the wilful defaulter mechanism is liable to be triggered by banks and financial institutions. I don’t see any kind of process which would effectively preclude challenges of the kind that we have seen in the recent past to the wilful defaulter tag being applied to wilful defaulters by banks. So if we have a process that restricts challenges in court, it will allow the process to be more efficiently pursued.”

While the efforts of the regulators to deal with wilful defaulters are laudable, issues like court challenges on lack of process and merit, absence of timelines for wilful defaulter determination and no platform for joint action by all the lenders can considerably undermine the regulatory regime that the RBI and SEBI are hoping to put in place.